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June 14, 2012

Spain, Cyprus Downgraded

Tsipras bets on euro as crisis escalates

Spain and Cyprus were both targets of downgrades from Moody’s on Wednesday, in the wake of a Fitch downgrade for the former and Moody’s bank downgrades for the latter. Bond yields topped 7% for Spain, and in Italy’s first bond sale since Spain’s bailout yields surged.

In Greece, Alexis Tsipras, the Syriza party leader, hopes to ditch austerity measures without driving his homeland from the euro, betting that the cost to other member nations will be too high to force an exit.

Bloomberg reported Thursday that Moody’s cut Spain’s rating late Wednesday to one notch above junk—a three-step drop—and also cut Cyprus from Ba1 to Ba3 after cutting the ratings of three of the country’s banks on Tuesday, over concerns that a Greek exit from the euro zone would leave it in an increasingly precarious position.

Cyprus could be in need of its own bailout before Greek elections are held Sunday, according to an Associated Press report. Finance Minister Vassos Shiarly suggested in the report that the country might have to seek a bailout before Greek elections are held on Sunday, although he was optimistic for favorable terms rather than harsh austerity measures. Cyprus carries a low fiscal deficit and public debt comapred with other members of the eurozone.

The action by Moody’s boosted the yield on Spain’s bonds above the level seen as sustainable; on 10-year bonds it rose 25 basis points to hit 7.2% on Thursday, a euro-era high, and two-year yields increased a similar amount.

In a Reuters report, Padhraic Garvey, head of investment grade strategy for ING, was quoted saying, "Spain is teetering on the edge of investment grade status and the risk in the near term is that investors begin to trade the risk they are cut to speculative grade. And if they do get cut further then you'll get another wave of selling."

It remains to be seen how much intervention will come from the other members of the eurozone, when just Wednesday Prime Minister Mariano Rajoy attacked central banks for failing to buy peripheral zone debt. The bailout agreed on for Spain over the weekend is aimed just at its financial sector and does not carry any additional harsh conditions, unlike the Greek bailout. Should matters worsen, Spain could be in the market for a full-scale bailout.

"If there's no reaction from Europe, it's a likely path [that yields will continue to rise]," Peter Schaffrik, head of European rates strategy at RBC Capital Markets, said in the report. "One of the only things we see that can change the situation on a lasting basis is some form of debt mutualization, which the Germans are reluctant to do."

Spain is scheduled to sell bonds in the market next Thursday, though details have not yet been announced.

Italy, meanwhile, sold bonds on Thursday and managed to find buyers for 4.5 billion euros’ worth ($5.653 billion) of debt. While demand was good, yield was up to its highest level since December. In a Bloomberg report, Markus Huber, head of German sales trading at ETX Capital in London, was quoted saying, “Today’s auctions most likely won’t manage to restore much calm in the markets, instead it rather reflects quite well how risk averse investors have become and how uncertainty within the eurozone and the European financial crisis itself continue to dominate the headlines and market action.”

Gary Jenkins, director of Swordfish Research, was not optimistic about either country’s chances of emerging unscathed from the financial crisis, saying in the report, "We are fast approaching the point where both Spain and Italy may have to be removed from the market."

In the last days before the second round of elections in Greece, Tsipras is counting on estimates of the high cost of a Greek exit from the joint currency to help him win not just the election but an end to the austerity measures that are conditions of Greece’s second bailout. He expects to do this without driving his country from the euro, and without Greece being forced to exit by other member countries or being cut off from funding.

Fitch Ratings said Thursday that if Greece did depart the euro, it would have a “severe” indirect impact on banks all around the eurozone and would need a “robust” policy response to ward off contagion. Italy would no doubt be next, according to Tsipras, who was quoted saying, “When you give a sign that a country can be led to hell, then they will rush to attack the next weak link, which is Italy.”

In fact, he is counting on such a response, betting that the cost of booting Greece from the joint currency would be so high for remaining members that they would instead choose to renegotiate the terms of Greece’s bailout. He said in the report, after being asked whether he had been in touch with any EU officials on the matter, that his position “is based on the analyses of the most credible European and international economists, cost-and-benefit analyses of one or the other scenario. Our conviction isn’t based on public relations or on some confirmations from politicians.”

On Wednesday Tsipras was quoted saying, “We have no sense that European partners will follow this tactic of blackmail heard from some quarters and stop funding. Something like that would be catastrophic not only for Greece but for the entire euro area.”

The question is whether Tsipras is correctly reading the political climate of the eurozone. While there have been indications from some eurozone leaders that they are willing to consider concessions, others are not so forgiving. Prime Minister Jean-Claude Juncker of Luxembourg is among those who have indicated that they would be amenable to relaxing some of the requirements for Greece to continue to receive financial assistance.

However, Finance Minister Wolfgang Schaeuble of Germany is firmly in the other camp. In a Stern magazine interview published on Wednesday, he said, “Crises are seldom fair. If the country wants to become competitive again, the minimum wage has to sink.”

Wolfango Piccoli, an analyst at Eurasia Group in London, believes Tsipras is betting on the wrong horse. In the report, Piccoli said, “Tsipras is misreading Greece’s European partners, especially the Nordic countries, as there is no willingness to give in to blackmail.”

But Tsipras is firm, and his very firmness may be contributing to his party’s popularity in the troubled country. “We have empty funds, public funds, bankrupt pension funds and a banking system hanging from a thread,” he said in the report. “The most important thing right now is to restore a climate of confidence.”

To do that, Syriza’s platform includes not just abrogation of bailout austerity measures and a renegotiation of the bailout’s terms, but also measures to promote economic and social development and taxes on the wealthy. In addition, Tsipras says the party will work to nationalize “and socialize” banks.

“It would be an incomprehensible, historical mistake today if European leaders could believe that a Europe without Greece could continue,” he was quoted saying. “An EU without Greece would be a politically, economically and culturally crippled Union.”

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